Alt-A mortgages are loans riskier than “prime” but less risky than sub-prime. “Reset” involves an interest rate change; “recast” is a change in the payment schedule.

Nelson sketches out the potential problem. He writes:

On a standard Adjustable Rate Mortgage (ARM) the interest rate ‘resets’ on its “Change Date” (after five years for a 5/1 ARM, etc.).

The payment ‘recasts’ exactly one month after the rate resets. (After the interest rate resets, the bank takes the new interest rate and the current balance, and recalculates a new payment that will pay off the loan over the remaining term.)

NOW… A large number of the Alt-A loans were “Interest-Only” or the even more dangerous “Pick-a-payment” variety. These loans can ‘recast’ when one of two things happen: either they reach their first “reset” date OR… and this is where they are dangerous… when they reach what is known as a “Balance Cap” or a “Negative Amortization Cap”.

With an Interest-Only loan, or with the “pick-a-payment” loans… any amount that was paid LESS THAN the FULL Principal and Interest amount is added to the base amount of the current balance (which – – as you can see, will be CONSTANTLY rising).

These loans have a Balance Cap… where the balance cannot exceed a certain amount (generally between 110% and 125% of the original loan amount… but varies by lender and state).

SO… The Alt-A recasts can happen when the loan-holder hits their “Balance Cap” – – even if their rate “reset” isn’t scheduled to happen for another year or two.

These loans were especially prevalent in the suburbs and exurban metro areas.

Among states, Minnesota is 6th in the percentage of Alt-A adjustable rate mortgages resetting in the next 12 months. It works out to nearly 2,000 mortgages.

Another 2,200 sub-prime mortgages are also expected to reset in the next 12 months.

The Fed data’s a snapshot, subject to change. But you see the immediate problem.

Bottom line: A lot of people who flocked to these mortgage deals are within a year or two of being socked with higher rates and/or stiffer monthly payments. Even more will feel that pinch within the next two to three years.

Combine that with still-high unemployment rates and it sets the scene for Mortgage Mess II in Minnesota with, perhaps, a bigger spotlight on the Twin Cities burbs.